Discussion of

“I Theory of Money”

by Markus Brunnermeier and Yuly Sannikov

Javier Bianchi

Minneapolis Fed & NBER

Central Bank of Korea

Not the opinion of the Federal Reserve

Overview

Goal: a unified framework to study financial stability and

price stability

Interesting paper at the intersection of money, banking &

macro!

Can’t do justice to the paper in 10’..

2 / 12

Overview

Goal: a unified framework to study financial stability and

price stability

Interesting paper at the intersection of money, banking &

macro!

Can’t do justice to the paper in 10’..

2 / 12

Outline of Discussion

Key Mechanisms

Illustration in Bewley’s model of fiat money, based on

Sargent-Wallace 1982, Ljungqvis-Sargent, CH 18

Outside money only

Inside and outside money

Effects of shocks to borrowing constraints and risk

Comments

Application/relevance of mechanism

Determinacy

3 / 12

Basic Idea/Story

Intermediaries:

Liabilities denominated in monetary units

Exposed to aggregate shocks

Negative aggregate shocks leads to losses of intermediaries

1 Fire sales leading to lower asset prices

→ further losses in asset side

2 Lower money creation leading to lower price level

→ further losses on liability side

Downward spirals reinforce each other

Price stability and financial stability go hand in hand

4 / 12

Basic Idea/Story

Intermediaries:

Liabilities denominated in monetary units

Exposed to aggregate shocks

Negative aggregate shocks leads to losses of intermediaries

1 Fire sales leading to lower asset prices

→ further losses in asset side

2 Lower money creation leading to lower price level

→ further losses on liability side

Downward spirals reinforce each other

Price stability and financial stability go hand in hand

4 / 12

Basic Idea/Story

Intermediaries:

Liabilities denominated in monetary units

Exposed to aggregate shocks

Negative aggregate shocks leads to losses of intermediaries

1 Fire sales leading to lower asset prices

→ further losses in asset side

2 Lower money creation leading to lower price level

→ further losses on liability side

Downward spirals reinforce each other

Price stability and financial stability go hand in hand

4 / 12

Basic Idea/Story

Intermediaries:

Liabilities denominated in monetary units

Exposed to aggregate shocks

Negative aggregate shocks leads to losses of intermediaries

1 Fire sales leading to lower asset prices

→ further losses in asset side

2 Lower money creation leading to lower price level

→ further losses on liability side

Downward spirals reinforce each other

Price stability and financial stability go hand in hand

4 / 12

Basic Idea/Story

Intermediaries:

Liabilities denominated in monetary units

Exposed to aggregate shocks

Negative aggregate shocks leads to losses of intermediaries

1 Fire sales leading to lower asset prices

→ further losses in asset side

2 Lower money creation leading to lower price level

→ further losses on liability side

Downward spirals reinforce each other

Price stability and financial stability go hand in hand

4 / 12

Basic Idea/Story

Intermediaries:

Liabilities denominated in monetary units

Exposed to aggregate shocks

Negative aggregate shocks leads to losses of intermediaries

1 Fire sales leading to lower asset prices

→ further losses in asset side

2 Lower money creation leading to lower price level

→ further losses on liability side

Downward spirals reinforce each other

Price stability and financial stability go hand in hand 4 / 12

Bewley’s model of fiat money

Uninsurable idiosyncratic income shocks yt. Deterministic

agg. dynamics

Only outside money. Central bank sets {M st }∞0

Households

maxE0

∞∑t=0

βtu(ct)

ct +Mt+1

Pt

= yt +Mt

Pt

+ Tt, Mt+1 ≥ 0

Market clearing∫mt(mt, yt)dΓt(mt, yt) =

Mst+1

Pt+1

At SS with Pt = P , Em =M

P⇒ Quantity theory of money

5 / 12

Bewley’s model of fiat money

Uninsurable idiosyncratic income shocks yt. Deterministic

agg. dynamics

Only outside money. Central bank sets {M st }∞0

Households

maxE0

∞∑t=0

βtu(ct)

ct +mt+1πt+1 = yt +mt + τt, mt+1 ≥ 0

Market clearing∫mt(mt, yt)dΓt(mt, yt) =

Mst+1

Pt+1

At SS with Pt = P , Em =M

P⇒ Quantity theory of money

5 / 12

Bewley’s model of fiat money

Uninsurable idiosyncratic income shocks yt. Deterministic

agg. dynamics

Only outside money. Central bank sets {M st }∞0

Households

maxE0

∞∑t=0

βtu(ct)

ct +mt+1πt+1 = yt +mt + τt, mt+1 ≥ 0

Market clearing∫mt(mt, yt)dΓt(mt, yt) =

Mst+1

Pt+1

At SS with Pt = P , Em =M

P⇒ Quantity theory of money

5 / 12

Bewley’s model of fiat money

Uninsurable idiosyncratic income shocks yt. Deterministic

agg. dynamics

Only outside money. Central bank sets {M st }∞0

Households

maxE0

∞∑t=0

βtu(ct)

ct +mt+1πt+1 = yt +mt + τt, mt+1 ≥ 0

Market clearing∫mt(mt, yt)dΓt(mt, yt) =

Mst+1

Pt+1

At SS with Pt = P , Em =M

P⇒ Quantity theory of money

5 / 12

Bewley with Inside and Outside Money

Private money creation bt+1 (real notes)

ct+Mt+1

Pt

+ bt+1︸ ︷︷ ︸at+1

= bt +Mt

Pt︸ ︷︷ ︸at

+btr+yt+Tt, bt+1 ≥ −φ,Mt+1 ≥ 0

Inside and outside money are perfect substitutes

→ Monetary equilibrium 1 + rt = Pt+1

Pt→ Friedman Rule

Market clearing

∫at(a, y)dΓt(a, y)) =

M st+1

Pt+1

6 / 12

Bewley with Inside and Outside Money

Private money creation bt+1 (real notes)

ct+Mt+1

Pt

+ bt+1︸ ︷︷ ︸at+1

= bt +Mt

Pt︸ ︷︷ ︸at

+btr+yt+Tt, bt+1 ≥ −φ,Mt+1 ≥ 0

Inside and outside money are perfect substitutes

→ Monetary equilibrium 1 + rt = Pt+1

Pt→ Friedman Rule

Market clearing

∫at(a, y)dΓt(a, y)) =

M st+1

Pt+1

6 / 12

Bewley with Inside and Outside Money

Private money creation bt+1 (real notes)

ct+Mt+1

Pt

+ bt+1︸ ︷︷ ︸at+1

= bt +Mt

Pt︸ ︷︷ ︸at

+btr+yt+Tt, bt+1 ≥ −φ,Mt+1 ≥ 0

Inside and outside money are perfect substitutes

→ Monetary equilibrium 1 + rt = Pt+1

Pt→ Friedman Rule

Market clearing

∫at(a, y)dΓt(a, y)) =

M st+1

Pt+1

6 / 12

Bewley with Inside and Outside Money

Private money creation bt+1 (real notes)

ct+Mt+1

Pt

+ bt+1︸ ︷︷ ︸at+1

= bt +Mt

Pt︸ ︷︷ ︸at

+btr+yt+Tt, bt+1 ≥ −φ,Mt+1 ≥ 0

Inside and outside money are perfect substitutes

→ Monetary equilibrium 1 + rt = Pt+1

Pt→ Friedman Rule

Market clearing

∫at(a, y)dΓt(a, y)) =

M st+1

Pt+1

6 / 12

Lessons from Stationary Equilibria∫(a(a, y))dΓ(a, y)) =

M s

P, bt+1 ≥ −φ

1 What are the effects of tightening borrowing constraint ↓ φ?

Lower private money creation, ⇒ ↓ P

2 Increase in idiosyncratic risk?

Lower private money creation, ⇒ ↓ P

* Credit crunches lead to deflation

Feedback in paper require ↓ Pt

7 / 12

Lessons from Stationary Equilibria∫(a(a, y))dΓ(a, y)) =

M s

P, bt+1 ≥ −φ

1 What are the effects of tightening borrowing constraint ↓ φ?

Lower private money creation, ⇒ ↓ P

2 Increase in idiosyncratic risk?

Lower private money creation, ⇒ ↓ P

* Credit crunches lead to deflation

Feedback in paper require ↓ Pt

7 / 12

Lessons from Stationary Equilibria∫(a(a, y))dΓ(a, y)) =

M s

P, bt+1 ≥ −φ

1 What are the effects of tightening borrowing constraint ↓ φ?

Lower private money creation, ⇒ ↓ P

2 Increase in idiosyncratic risk?

Lower private money creation, ⇒ ↓ P

* Credit crunches lead to deflation

Feedback in paper require ↓ Pt

7 / 12

Lessons from Stationary Equilibria∫(a(a, y))dΓ(a, y)) =

M s

P, bt+1 ≥ −φ

1 What are the effects of tightening borrowing constraint ↓ φ?

Lower private money creation, ⇒ ↓ P

2 Increase in idiosyncratic risk?

Lower private money creation, ⇒ ↓ P

* Credit crunches lead to deflation

Feedback in paper require ↓ Pt

7 / 12

Lessons from Stationary Equilibria∫(a(a, y))dΓ(a, y)) =

M s

P, bt+1 ≥ −φ

1 What are the effects of tightening borrowing constraint ↓ φ?

Lower private money creation, ⇒ ↓ P

2 Increase in idiosyncratic risk?

Lower private money creation, ⇒ ↓ P

* Credit crunches lead to deflation

Feedback in paper require ↓ Pt

7 / 12

Brunnermeir-Sannikov

Impressive! Aggregate shocks, not just stationary eq..

Richer portfolio: trade in safe and risky assets

Networth of intermediaries determine endogenous risk and

money creation

Feedback between money multiplier and financial sector

Extensions with long-term debt → valuation effects

Redistribution and insurance effects of monetary policy

Methods: (Brunnermeir-Sannikov, 2014). Full eq. dynamics also

in discrete time. Pros? Cons?

8 / 12

Brunnermeir-Sannikov

Impressive!

Aggregate shocks, not just stationary eq..

Richer portfolio: trade in safe and risky assets

Networth of intermediaries determine endogenous risk and

money creation

Feedback between money multiplier and financial sector

Extensions with long-term debt → valuation effects

Redistribution and insurance effects of monetary policy

Methods: (Brunnermeir-Sannikov, 2014). Full eq. dynamics also

in discrete time. Pros? Cons?

8 / 12

Brunnermeir-Sannikov

Impressive! Aggregate shocks, not just stationary eq..

Richer portfolio: trade in safe and risky assets

Networth of intermediaries determine endogenous risk and

money creation

Feedback between money multiplier and financial sector

Extensions with long-term debt → valuation effects

Redistribution and insurance effects of monetary policy

Methods: (Brunnermeir-Sannikov, 2014). Full eq. dynamics also

in discrete time. Pros? Cons?

8 / 12

Brunnermeir-Sannikov

Impressive! Aggregate shocks, not just stationary eq..

Richer portfolio: trade in safe and risky assets

Networth of intermediaries determine endogenous risk and

money creation

Feedback between money multiplier and financial sector

Extensions with long-term debt → valuation effects

Redistribution and insurance effects of monetary policy

Methods: (Brunnermeir-Sannikov, 2014). Full eq. dynamics also

in discrete time. Pros? Cons?

8 / 12

Brunnermeir-Sannikov

Impressive! Aggregate shocks, not just stationary eq..

Richer portfolio: trade in safe and risky assets

Networth of intermediaries determine endogenous risk and

money creation

Feedback between money multiplier and financial sector

Extensions with long-term debt → valuation effects

Redistribution and insurance effects of monetary policy

Methods: (Brunnermeir-Sannikov, 2014). Full eq. dynamics also

in discrete time. Pros? Cons?

8 / 12

Brunnermeir-Sannikov

Impressive! Aggregate shocks, not just stationary eq..

Richer portfolio: trade in safe and risky assets

Networth of intermediaries determine endogenous risk and

money creation

Feedback between money multiplier and financial sector

Extensions with long-term debt → valuation effects

Redistribution and insurance effects of monetary policy

Methods: (Brunnermeir-Sannikov, 2014). Full eq. dynamics also

in discrete time. Pros? Cons?8 / 12

Application/Relevance of Mechanism

Are intermediaries really exposed to deflation risk (TIPS,

options, etc)?

If they are, why do they expose themselves to

such risk? Or is it not a big risk in the first place? Good

policy?

No deflation nor Fisherian debt-deflation in US crisis. Drop

in money multiplier in US crisis was mainly due to increase

in reserve holdings (Bianchi-Bigio, 2013)?

Emerging markets: Alternative debt-deflation through foreign

currency and movements in real exchange rate might be more

relevant.

9 / 12

Application/Relevance of Mechanism

Are intermediaries really exposed to deflation risk (TIPS,

options, etc)? If they are, why do they expose themselves to

such risk?

Or is it not a big risk in the first place? Good

policy?

No deflation nor Fisherian debt-deflation in US crisis. Drop

in money multiplier in US crisis was mainly due to increase

in reserve holdings (Bianchi-Bigio, 2013)?

Emerging markets: Alternative debt-deflation through foreign

currency and movements in real exchange rate might be more

relevant.

9 / 12

Application/Relevance of Mechanism

Are intermediaries really exposed to deflation risk (TIPS,

options, etc)? If they are, why do they expose themselves to

such risk? Or is it not a big risk in the first place? Good

policy?

No deflation nor Fisherian debt-deflation in US crisis. Drop

in money multiplier in US crisis was mainly due to increase

in reserve holdings (Bianchi-Bigio, 2013)?

Emerging markets: Alternative debt-deflation through foreign

currency and movements in real exchange rate might be more

relevant.

9 / 12

Application/Relevance of Mechanism

Are intermediaries really exposed to deflation risk (TIPS,

options, etc)? If they are, why do they expose themselves to

such risk? Or is it not a big risk in the first place? Good

policy?

No deflation nor Fisherian debt-deflation in US crisis. Drop

in money multiplier in US crisis was mainly due to increase

in reserve holdings (Bianchi-Bigio, 2013)?

Emerging markets: Alternative debt-deflation through foreign

currency and movements in real exchange rate might be more

relevant.

9 / 12

Application/Relevance of Mechanism

Are intermediaries really exposed to deflation risk (TIPS,

options, etc)? If they are, why do they expose themselves to

such risk? Or is it not a big risk in the first place? Good

policy?

No deflation nor Fisherian debt-deflation in US crisis. Drop

in money multiplier in US crisis was mainly due to increase

in reserve holdings (Bianchi-Bigio, 2013)?

Emerging markets: Alternative debt-deflation through foreign

currency and movements in real exchange rate might be more

relevant. 9 / 12

Note on (In)Determinacy

Monetary models often subject to indeterminacies (Sargent-Wallace

1975)

Take Bewley model with inside money (nominal bonds)

Ptct + qtBt+1 = Ptyt +Bt

Let qt = qtPt+1

Pt, bt = Bt/Pt

Market clearing∫bt+1(bt, yt)Γt(bt, yt) = 0

Multiple paths of prices consistent with sequence of q∗t

But initial P0 has redistributive effects bt = Bt/Pt → {q∗t }

Important difference in the paper seems to be outside money.

Clarify determinacy of Pt— key for deflation spiral

10 / 12

Note on (In)Determinacy

Monetary models often subject to indeterminacies (Sargent-Wallace

1975)

Take Bewley model with inside money (nominal bonds)

Ptct + qtBt+1 = Ptyt +Bt

Let qt = qtPt+1

Pt, bt = Bt/Pt

Market clearing∫bt+1(bt, yt)Γt(bt, yt) = 0

Multiple paths of prices consistent with sequence of q∗t

But initial P0 has redistributive effects bt = Bt/Pt → {q∗t }

Important difference in the paper seems to be outside money.

Clarify determinacy of Pt— key for deflation spiral

10 / 12

Note on (In)Determinacy

Monetary models often subject to indeterminacies (Sargent-Wallace

1975)

Take Bewley model with inside money (nominal bonds)

ct + qtbt+1 = yt + bt

Let qt = qtPt+1

Pt, bt = Bt/Pt

Market clearing∫bt+1(bt, yt)Γt(bt, yt) = 0

Multiple paths of prices consistent with sequence of q∗t

But initial P0 has redistributive effects bt = Bt/Pt → {q∗t }

Important difference in the paper seems to be outside money.

Clarify determinacy of Pt— key for deflation spiral

10 / 12

Note on (In)Determinacy

Monetary models often subject to indeterminacies (Sargent-Wallace

1975)

Take Bewley model with inside money (nominal bonds)

ct + qtbt+1 = yt + bt

Let qt = qtPt+1

Pt, bt = Bt/Pt

Market clearing∫bt+1(bt, yt)Γt(bt, yt) = 0

Multiple paths of prices consistent with sequence of q∗t

But initial P0 has redistributive effects bt = Bt/Pt → {q∗t }

Important difference in the paper seems to be outside money.

Clarify determinacy of Pt— key for deflation spiral

10 / 12

Note on (In)Determinacy

Monetary models often subject to indeterminacies (Sargent-Wallace

1975)

Take Bewley model with inside money (nominal bonds)

ct + qtbt+1 = yt + bt

Let qt = qtPt+1

Pt, bt = Bt/Pt

Market clearing∫bt+1(bt, yt)Γt(bt, yt) = 0

Multiple paths of prices consistent with sequence of q∗t

But initial P0 has redistributive effects bt = Bt/Pt → {q∗t }

Important difference in the paper seems to be outside money.

Clarify determinacy of Pt— key for deflation spiral

10 / 12

Note on (In)Determinacy

Monetary models often subject to indeterminacies (Sargent-Wallace

1975)

Take Bewley model with inside money (nominal bonds)

ct + qtbt+1 = yt + bt

Let qt = qtPt+1

Pt, bt = Bt/Pt

Market clearing∫bt+1(bt, yt)Γt(bt, yt) = 0

Multiple paths of prices consistent with sequence of q∗t

But initial P0 has redistributive effects bt = Bt/Pt → {q∗t }

Important difference in the paper seems to be outside money.

Clarify determinacy of Pt— key for deflation spiral10 / 12

Policy

Liquidity spirals and deflation spirals cause “excessive

borrowing”

Would be interesting to study how the benefits from

macroprudential policy vary when monetary policy is

conducted optimally

Models of optimal macroprudential policy typically abstract

from monetary policy (Lorenzoni, 2008; Bianchi, 2011;

Bianchi-Mendoza 2013)

Time inconsistency aspects of monetary and macropru?

11 / 12

Conclusions

Very nice and interesting paper!

Elegant model providing a unified framework for the study of

price and financial stability

Clarify price level determination

Quantitative?

Optimal Policy? Macroprudential tools?

12 / 12

Conclusions

Very nice and interesting paper!

Elegant model providing a unified framework for the study of

price and financial stability

Clarify price level determination

Quantitative?

Optimal Policy? Macroprudential tools?

12 / 12